Chapter 1.

A Framework for Financial Accounting

LO1-1 Describe the two primary functions of financial accounting.
Accounting is “____________________.” It's the language companies use to tell their financial
story. More precisely, accounting is a system of maintaining records of a company’s operations
and communicating that information to decision makers.

Illustration 1-1
• Accounting information provided to external users is referred to as financial accounting,
which is the focus of this book.
• The two functions of financial accounting are
❑ to _______________ business activities of a company, and
❑ to _______________ those measurements to external parties for decision-making
purposes.

T/F Questions
• Accounting information is used by creditors to decide whether to invest in a company's
stock.
• Financial statements are periodic reports published by the company for the purpose of
providing information to managers.
• The primary functions of financial accounting are to measure business activities of a
company and to communicate those measurements to internal parties for decision-
making purposes.
LO1-2 Understand the business activities that financial accounting measures.
Fundamental activities of a business:
• _______________ activities: transactions the company has with investors and creditors
• _______________ activities: transactions involving the purchase and sale of resources
that are expected to benefit the company for several years
• _______________ activities: transactions that relate to the primary operations of the
company
LO1-3 Determine how financial accounting information is communicated through financial
statements.
__________________________ are periodic reports published by the company for the purpose
of providing information to external users.

1) _______________ Statement (Statement of Operation)

• Reports the company’s revenues and expenses over an interval of time
❑ ____________: the amounts recognized when the company sells products or
provides services to customers.
❑ ____________: the costs of providing products and services and other business
activities during the current period.
❑ ____________: the difference between revenues and expenses. Other common
names for net income include earnings or profit.
✓ If revenues > expenses, then net income
✓ If revenues < expenses, then net loss
• Compares revenues and expenses for the current period to assess the company’s ability to
earn a profit from running its operations.

Illustration 1-5
2) Statement of Stockholders’ Equity
• Summarizes the changes in stockholders’ equity over an interval of time. Stockholders’
equity has two primary components—common stock and retained earnings
❑ _______________ represents amounts invested by stockholders (the owners of the
corporation) when they purchase shares of stock. Common stock is an external source of
stockholders’ equity.
❑ _______________, on the other hand, is an internal source of stockholders’ equity. Its
balance represents all net income minus all dividends over the life of the company.
✓ Dividends represent the payment of cash but are not considered an expense in
running the business.
✓ The change in retained earnings equals net income less dividends for the period.

Illustration 1-6

MCQ. Net income (loss) is reported on which of the following financial statement(s)?
A. Statement of stockholders' equity and balance sheet
B. Income statement and statement of stockholders' equity
C. Balance sheet and income statement
D. Net income is reported only on the income statement

3) ________________________ (Statement of Financial Position)

• Presents the financial position of the company on a particular date
• Accounting equation summarizes the financial position of a company and provides a
fundamental model of business valuation
• Accounting Equation:

❑ ___________: the resources of the company

✓ Examples: cash, equipment, supplies, inventory for sale to customers, buildings,
land, and investments.
❑ ___________: amounts owed to creditors
✓ Examples: amounts owed to suppliers, employees, utility companies, and the
government (in the form of taxes).
✓ Liabilities typically include claims that must be paid by a specified date.
❑ __________________________: owners’ claims to resources
✓ These claims arise from two primary sources:
(1) __________________: contributions by the owners themselves, and
(2) __________________: net resources generated by company operations.
✓ You can also think of stockholders' equity as total assets minus total liabilities.

Illustration 1-7
T/F Questions
• The balance sheet is a financial statement that reports the company's revenues and
expenses over an interval of time.
• Cash, inventory for sale to customers, supplies, and buildings are examples of liabilities.
• The costs related to rent, utilities, and salaries in the current reporting period are
examples of liabilities.
• Expenses include a company’s costs of providing products and services to customers, as
well as cash payments to its stockholders.
• Stockholders' equity arises from two primary sources–common stock and revenue.

MCQ. Which of the following accounts is reported on the statement of stockholders' equity?
A. Supplies
B. Common Stock
C. Accounts Receivable
D. Accounts Payable

4) Statement of Cash Flows

• Measures activities involving cash receipts and cash payments over an interval of time.
We can classify all cash transactions into three categories that correspond to the three
fundamental business activities—operating, investing, and financing.

❑ _______________ cash flows include cash receipts and cash payments for transactions
involving revenue and expense activities during the period. In other words, operating
activities include the cash effects of the same activities that are reported in the income
statement to calculate net income.
❑ _______________ cash flows generally include cash transactions for the purchase and
sale of investments and long-term assets. Long-term assets are resources owned by a
company that are thought to provide benefits for more than one year.
❑ _______________ cash flows include cash transactions with lenders, such as borrowing
money and repaying debt, and with stockholders, such as issuing stock and paying
dividends.
 Illustration 1-8

Exercise Question. Eagle Corporation operates Magnetic Resonance Imaging (MRI) clinics
throughout the Northeast. At the end of the current period, the company reports the following
amounts: Assets = $42,000; Liabilities = $23,000; Dividends = $2,200; Revenues = $12,400;
Expenses = $8,200.

Required:
1. Calculate net income.

2. Calculate stockholders' equity at the end of the period.

❖ Link among Financial Statements

Illustration 1-9

• All transactions that affect revenues or expenses reported in the income statement
ultimately affect the balance sheet through the balance in retained earnings.

LO1-4 Describe the role that financial accounting plays in the decision-making process.

• Accounting serves an important role in a prosperous society by _______________

economic activity and _______________ useful information to help investors and
creditors make good decisions.
Concept Checker

1. The total resources of a company are referred to as:

A. Liabilities
B. Revenues
C. Assets
D. Expenses

2. The amounts recorded when the company sells products or provides services to customers are
referred to as:
A. Liabilities
B. Revenues
C. Assets
D. Expenses

3. Which of the following accounts would appear in a company’s income statement?

A. Accounts Payable
B. Cash
C. Dividends
D. Rent Expense

4. Which relationship is reflected in the balance sheet?

A. Revenues − Expenses = Net income
B. Assets = Liabilities + Stockholders’ Equity
C. Assets − Liabilities = Net Income
D. Assets = Revenues + Dividends

1. C 2.B 3.D 4.B